10 Ways Taxable Accounts Boost Retirement Planning

2. No RMDs.

Unlike traditional IRAs, 401(k)s or other traditional retirement accounts, there are no required minimum distributions from a taxable account. Money held in a taxable account can be left there indefinitely if your client wants.

On the other hand, once your client reaches the age where distributions must commence, they have no choice but to take RMDs from their from tax-deferred retirement accounts each year whether or not they need the money for living expenses in retirement.

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3. No income restrictions.

Unlike a Roth IRA or pre-tax contributions to a traditional IRA, there are no income restrictions that limit the ability to add money to taxable accounts. Those who earn too much are prohibited from contributing to a Roth IRA. There are also income restrictions on the ability to contribute to a traditional IRA on a pre-tax basis if your client is covered by a workplace retirement plan.

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4. Tax diversification.

Having money in taxable accounts in addition to tax-advantaged retirement accounts offers clients additional planning flexibility around their retirement withdrawals as the tax rules evolve over time.

According to Pete and Bill Bush, Financial Advisors with Horizon Financial Group, Cetera Advisors and authors of The Runway Decade: Building a Pre-retirement Flight Plan in Your Fifties, “When coordinated properly with tax-deferred retirement distributions, withdrawals from Roth accounts and qualified HSA distributions, taxable accounts can play an important role in providing income and another tool to use in one’s overall tax strategy in planning for retirement.”

On a cautionary note, Pete and Bill point out, “Any taxable interest or nonqualified dividends that assets produce in taxable accounts, whether received in cash or re-invested, are taxable at ordinary income tax rates. Dividends, interest, and capital gains from taxable accounts all count toward the thresholds that determine whether your Social Security benefit is subject to tax and whether or not you’ll pay a Medicare IRMAA surcharge.”

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5. Estate planning benefits.

Passing an IRA on to most non-spousal beneficiaries became less advantageous with the passage of the Secure Act, which took effect in 2020. The Secure Act eliminated the ability to stretch an inherited IRA for non-spouses who are not considered to be eligible designated beneficiaries. Instead, these beneficiaries must withdraw the entire amount of the inherited IRA within a 10-year period.

Taxable accounts can take advantage of a step-up in basis when being passed to your client’s heirs. The step-up in basis eliminates unrealized capital gains on your client’s assets such as stocks, ETFs, mutual funds, real estate and other assets. This is a powerful tool in being able to pass assets to heirs with a minimal tax impact.

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6. Taxable accounts can help make up for poor 401(k) options.

Not every 401(k) plan offers low-cost, solid investment choices. If this is a situation that your client faces with their employer’s plan, then it can make sense to focus on investing for retirement through a taxable account that includes investments you select for them.

If their 401(k) offers a match, it generally makes sense for your client to contribute enough to earn the full employer match. Beyond that, with your guidance, their focus should be on contributing to an IRA, if feasible, and on investing through their taxable brokerage accounts.

The greater range of investments available to clients, often at a lower cost than what may be available in their 401(k), can allow them to build up their nest egg at a faster rate compared with investments in a poorly run, high-cost 401(k) with a poor investment lineup.

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7. Greater flexibility and access.

One of the downsides of having money in an IRA, a 401(k) or other retirement account, or in a non-qualified annuity, is that withdrawals prior to age 59 ½ will generally be subject to a 10% penalty. This is in addition to any taxes that would normally be due with the distribution.

While you may not like to see your client divert money from their retirement savings to other uses, sometimes this is unavoidable. Having assets in a taxable account allows for this flexibility if needed. There would be no penalties, and the tax implications would be there in the case of any capital gains on the sale of an investment asset that would be realized by accessing cash from the account.

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8. Tax loss harvesting.

Taxable accounts can offer a number of tax planning options. For example, your clients can take advantage of tax loss harvesting in years when it applies to their portfolio. They can realize losses to offset capital gains on other holdings and use up to $3,000 in excess losses to offset other income. Excess losses can be carried over as well. Tax loss harvesting can be a valuable tool when rebalancing your client’s portfolio.

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9. Charitable giving flexibility.

Appreciated securities can be an excellent way to make charitable contributions for those clients who are charitably inclined and in a financial position to do so. While qualified charitable distributions (QCDs) are an option in a traditional IRA, clients must wait until age 70 ½ to use this option.

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10. Taxable and tax-preferred retirement accounts work well together.

The best of all worlds for most clients is to use both tax-advantaged retirement accounts and taxable accounts together to help build their retirement nest egg. This strategy offers tax benefits on contributions to traditional retirement accounts and the ability to let their investments grow tax-free or tax-deferred during their working years and beyond.

Adding taxable accounts offers greater flexibility and planning options. The benefits of tax diversification in retirement and for estate planning are key as well. Using both types of accounts allows your clients to reap the benefits of proper asset location of investments between the two types of accounts.

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